Dosi C., Moretto M. (2015).
Procurement with Unenforceable Contract Time and the Law of Liquidated Damages. Journal of Law, Economics, & Organization, 31 (11), 160-186
Time overruns are common in public projects and are not confined to inherently complex tasks. One explanation is that sellers can undergo changes in production costs which generate a value of waiting. Using the real-option approach, we examine the effects of the lack of incentives for on-time delivery on competitive bids for a fixed-price procurement contract. Next, we analyze the effects of liquidated damages aimed at protecting the buyer for the expected losses due to project delays. We show that when the expectation damage measure fails to discourage time overruns, a liquidated damages stipulation does not lead to a Pareto superior outcome. Although liquidated damages tend to make the seller better off, the buyer’s expected payoff is lower than when the contract does not provide for any damages for breach.